KLA (NASDAQ:KLAC) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that KLA Corporation (NASDAQ:KLAC) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for KLA

How Much Debt Does KLA Carry?

As you can see below, at the end of March 2024, KLA had US$6.63b of debt, up from US$5.89b a year ago. Click the image for more detail. However, because it has a cash reserve of US$4.29b, its net debt is less, at about US$2.33b.

How Strong Is KLA's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that KLA had liabilities of US$4.46b due within 12 months and liabilities of US$7.40b due beyond that. Offsetting these obligations, it had cash of US$4.29b as well as receivables valued at US$1.71b due within 12 months. So it has liabilities totalling US$5.86b more than its cash and near-term receivables, combined.

Since publicly traded KLA shares are worth a very impressive total of US$100.7b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

KLA has a low net debt to EBITDA ratio of only 0.60. And its EBIT easily covers its interest expense, being 15.3 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, KLA's EBIT dived 16%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if KLA can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, KLA generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, KLA's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its EBIT growth rate. Taking all this data into account, it seems to us that KLA takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for KLA you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.